Irrational exuberance, Indian-style?

Your move, Mr. Prime Minister. That is effectively what India's central bank governor signaled to Narendra Modi when he lower interest rates a touch last week.

The Reserve Bank of India made the right call, responding to what economists like Shubhada Rao of Yes Bank characterize as a "dramatic decline in inflation" to 1.5% in June. Yet worrisome data on industrial production, purchases by managers overseeing manufacturing centers and money supply trends could have warranted a bigger cut than just 25 basis points to 6%.

Governor Urjit Patel held back to make a point: Modi must talk less about epochal reforms to increase competitiveness and raise living standards and act more to implement his Modinomics program. RBI policy committee members called on Modi to accelerate government projects to address the "urgent need" for greater private investment. It is a vitally important message, but one investors do not seem to be hearing.

Mumbai stocks have been on a tear all year, with the S&P BSE Sensex Index and price-to-earnings ratios at record highs. And credit where it is due: of all the self-described change agents in Asia -- including China's Xi Jinping and Japan's Shinzo Abe -- Modi has been most successful in engineering a profound transformation in the domestic growth narrative.

Even risk averse Japanese investors are clamoring India's way. Nomura's India equity fund, for example, more than quadrupled toward the US$4 billion mark over the past year. As of the end of June, Japanese investors had gorged on a record $13 billion of bonds and stocks, an Indian buying-binge that all indications suggest extended beyond July, too.

Modi has pulled off bigger structural-change wins than Abenomics. Unlike the RBI, Abe's central bank has eased spectacularly again and again. The Bank of Japan's largess took the onus off Tokyo to deregulate, loosen labor markets and catalyze a startup boom. Modi, by contrast, opened sectors like aviation, defense and insurance, shepherded major tax changes through parliament and began the task of curbing bureaucracy and pruning ease-of-doing-business regulations.

The bulls stampeding across Dalal Street, Mumbai's Wall Street, are hoping there is much more where that came from. Unfortunately, though, they are likely to be disappointed.

As Patel's team suggested, Modi needs to get on with the really big, contentious upgrades -- labor, land, governance, opening the retail sector, streamlining the tax code -- if India is going to keep gross domestic product close to 7%. Since May 2014, Modi has avoided touchier reforms that might irk vested interests.

Worse, populist Modi appears to be taking a page from Donald Trump in Washington by entering into permanent-campaign mode. There are worrisome signs that major reforms will be delayed until after the 2019 election. Odds are we will see minor, politically-advantageous tweaks, while New Delhi leans on the central bank to do more to support growth. Modi's re-election calculus might halt all risk-taking from here on out.

The basic competence of Modi's team, and New Delhi's institutions, is under a harsh spotlight after two botched policy rollouts in the last eight months. The first, on Nov. 8, was a hasty and chaotic move to yank all high-denomination bills -- 500- and 1,000-rupee notes -- out of circulation. Modi's audacious demonetization gambit to root out "black money" profits from tax evasion, political corruption and other crimes was marred by dreadful execution.

An amateur-hour vibe also ran through the July 1 debut of a national goods-and-services tax. What should have been a major reform coup for Modi, says opposition lawmaker Shashi Tharoor, "proved both messy and disruptive." Mass confusion over which tax rate applies to what sector, which documents are due when and which compliance requirements apply to whom is having its own chilling effect on GDP.

Meanwhile, boldness is needed to tackle India's most pressing challenges, including mounting bad loans. They are at a 15-year high at state-run lenders, raising questions about basis financial stability. As investors learned from Japan in the 1990s and China today, official estimates of toxic assets tend to be as fanciful as they are opaque. When New Delhi cops to about $191 billion of zombie loans on bank balance sheets, assume the problem is considerably bigger.

In a recent Moody's Investors Service poll of Hong Kong investors, 70% agreed India's banking system is the clearest and most present danger to stability in South Asia and SoutheastAsia. That should worry investors chasing the rally in Sensex shares. As we learned from Japan and Southeast Asia in the 1990s, Wall Street in 2008 and Europe in 2011, the fallout from risky banking practices bleeds everywhere.

Until now, Modi has left the problem to the RBI. But this a product of misallocated credit, misplaced priorities, blurred lines between public and private sectors and, ultimately, local business culture. Regulators need to tighten safeguards. Modi's team should create a mechanism to take distressed assets off balance sheets, perhaps akin to America's Resolution Trust Corp. from the 1980s.

It is not a given that irrational exuberance is coursing through Mumbai. Modi morphing India into a "consensus trade" everyone -- including the Japanese -- wants in on is to be applauded. But as Patel's RBI suggests, India's promise rests on a shaky foundation that New Delhi is not repairing fast enough. Unless Modinomics aims bigger and unleashes a big bang, any new Sensex records would put India firmly into frothy territory.